Environmental information

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Master thesis

Spring semester 2008 Supervisor: Henrik Nilsson Author: Daniel Boström

Environmental information

- A study of environmental disclosure in financial analyst reports,

annual reports, CSR reports and environmental risk profiles

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SUMMARY

The awareness of environmental issues has increased among the public the last decades.

An environmental movement is occurring and companies are beginning to adapt themselves and their business activities to the changing view of environmental issues.

Greater attention are turning to companies around the world due to the view that they have a responsibility concerning environmental and sustainability matters in their business operations. The development of environmental guidelines such as the Global Reporting Initiative and the presenting of separate Corporate Social Responsibility (CSR) reports illustrate the emerged demand of an environmental awareness from various stakeholders. Government regulations and inter-continental agreements of carbon taxes, emission trade rights and various environmental targets are influencing the operations and the environmental approach for the companies.

An important link in the information chain is the financial analysts and their role as information intermediaries. The characteristics of their profession combined with their expertise knowledge of evaluating companies are reasons behind their function in the investment value chain. Traditionally, the valuation of companies has been based on financial figures and the models derive from typical tangible assets such growth numbers, estimated future earnings and cash flow. Environmental issues have throughout the years been considered of secondary importance due to the specific kind of information it represents.

This study examines factors influencing the amount of environmental information presented in financial analyst reports. The amount of environmental information presented in annual reports, CSR reports and an environmental risk profile developed by GES Investment Services have been selected as predictor variables to determine the amount of environmental information in the financial analysts’ reports.

40 companies from the industrial sector have been included in the study and the results reveal that no or very little environmental information can be found in the financial analyst reports. The financial analysts’ seem to prioritize other kinds of information when evaluating companies and creating analyst reports. The study also reveals that companies with separate CSR reports seem to have a higher amount of environmental information presented in annual reports as well as a better environmental risk profile.

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1. INTRODUCTION ...1

2. THEORY ...3

2.1 Corporate reporting practice ... 3

2.1.1 Corporate Social Responsibility (CSR) ... 3

2.2 Environmental risk ... 4

2.3 Financial analysts ... 5

2.3.1 Environmental information among financial analysts ... 6

2.4 Impact on valuation ... 6

2.5 Environmental performance and disclosure ... 7

2.6 The value relevance theory ... 8

2.6.1 Cost-concerned vs. value-concerned approach ... 8

2.7 Summary of the theoretical background ... 9

3. METHODOLOGY ... 11

3.1 The data material ... 11

3.1.1 The Risk Rating Index ... 12

3.1.2 The annual reports ... 12

3.1.3 Corporate Social Responsibility (CSR) reporting ... 13

3.1.4 The financial analyst reports ... 13

3.2 Constructing the analysis model (statistical framework) ... 13

3.2.1 Correlation coefficients ... 14

3.2.2 Regression analysis ... 14

3.2.3 The regression model... 15

3.2.4 Research hypothesis... 15

3.3 Summary of the data collection phase ... 16

4. RESULTS ... 18

4.1. Scale of measure ... 18

4.1.1 All 40 companies ... 18

4.1.2 Companies with separate CSR reports ... 19

4.1.3 Companies without separate CSR reports ... 20

4.1.4 Summary of the dividing of the companies based on separate CSR reports ... 20

4.1.4.1 Financial analyst reports ... 21

4.1.4.2 Annual reports and environmental risk rating ... 21

4.2 Correlation ... 22

4.2.1 All 40 companies ... 22

4.3 Regression analysis ... 24

4.3.1 All 40 companies ... 24

4.4 Hypothesis testing ... 26

4.4.1 Hypothesis I... 26

4.4.2 Hypothesis II ... 26

4.4.3 Hypothesis III ... 26

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6. CONCLUSIONS ... 28

5.1 The abscence of environmental information in financial analyst reports ... 28

5.2 Other possibly influcencing factors... 28

5.3 Suggestions for future research ... 29

REFERENCES ... 30

APPENDIX 1. Key words included in the concept of environmental information APPENDIX 2. GES Environmental Risk Rating

APPENDIX 3. Register of annual reports

APPENDIX 4. Register of financial analyst reports

APPENDIX 5. Specification of the financial analyst reports APPENDIX 6. Plotting the correlation

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CHAPTER 1 – INTRODUCTION

1. INTRODUCTION

We believe our technical and commercial expertise entails a duty to contribute to sustainable development – a principle we wholeheartedly endorse, mindful of its social, ethical and environmental elements. In awareness of our responsibilities as a corporate citizen, we define economy, ecology and social commitment as objectives of equal rank¹. The cited text above and similar enunciations are commonly found in annual reports among publicly listed companies. An important viewpoint is what implications these publicly stated policies might have on investors and professionals within the business field. Researchers suggest corporate communication is a fundamental factor to the success of a company, with trends emerging towards value-adding through the

improvement of corporate reporting and corporate governance². In terms of the general corporate reporting practice, according to Zairi & Letza³, companies tend to report what they do for themselves, as opposite to what the market needs and what the customer wants. The implications of these findings that companies need to become clearer about the purpose of their reporting and provide the end-users what they need to know to be able to become more overall efficient as an organization.

The awareness of environmental issues among the society have increased the last couple of decades, and perhaps especially over the last few years. The society is beginning to create an awareness of the importance of environmental considerations and the social responsibility among companies. This shift is also occurring due to pressure from governments and by inter-continental agreements. Agreements such as the 1997 Kyoto Climate Prevention Act is putting pressure on companies to reduce emissions, to use their resources more efficiently and be considerate against the impact on the surrounding environment. Such initiatives will affect the bottom lines of companies through the introduction of various environmental objectives, such as carbon taxes and emissions trade rights⁴.

At some point the companies themselves have started to realize the importance of understanding the massive environmental movements that are occurring right now.

Companies have begun to recognize the effects, both directly through the affection of the bottom line, as well as more indirectly by a way to improve their public relations through environmental concerns and activities. The financial analysts act as an important and vital link in the investment value chain between the companies, portfolio/fund managers, the stock market and other stakeholders related to the companies.

Although this movement is occurring, there is no transparency regards to what, when, where and perhaps most important how this reporting can be presented by the companies, and how it in turn will be interpreted by various stakeholders. Voluntarily social and

1 Bayer, Annual Report 2004, p. 2

2 Goodman, Michael B (2006) Corporate communication practice and pedagogy at the dawn of the new millennium. Corporate Communications: An International Journal, p. 203

3 Zairi, Mohamed & Steve Letza (1994). Corporate Reporting. Management decision, p. 38-39

4 Hill, Malcolm (2001) Sustainability, greenhouse gas emissions and international operations management. International Journal of Operations & Production Management, p. 1517-1518

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CHAPTER 1 – INTRODUCTION

environmental reporting may very well improve corporate behavior, but does certainly not automatically lead to better behavior. In essence, researchers such as Gray⁵ concludes that the probably only long-term way to ensure good corporate behaviour, is to redefine the definition of shareholder value into focusing on such issues, rather than solely on monetary growth.

The purpose of this study is to investigate and examine factors affecting environmental information in financial analyst reports. Financial analysts are commonly seen as the link between companies and the society, since they in their profession examine various corporate related information, evaluate and forward their interpretations to other

stakeholders. The aim of this thesis is to investigate whether the amount of environmental information in annual reports and the environmental risk rating of a company may

influence the amount of environmental information found in financial analyst reports. In addition a fourth variable will complement the research, which is the matter if the companies present or do not present a separate Corporate Social Responsibility (CSR) report and how that may influence the amount of environmental information in the financial analyst reports.

The hypotheses for the conduction of the study have hence been formuled as following:

• Hypothesis I: Companies with more environmental information presented in annual reports will have more environmental information presented in financial analyst reports.

• Hypothesis II: Companies with better environmental risk rating (= seen as an approximation of better environmental risk profile) will have more environmental information presented in financial analyst reports.

• Hypothesis III: Companies with separate Corporate Social Responsibility (CSR) reports will have more environmental information presented in financial analyst reports.

This study will contribute to the existing research by providing an insight into how environmental information from three types of related sources might affect the amount of environmental information in financial analyst reports. Besides the research area, the findings will be of relevance to practitioners within the financial business field, in terms of how to connect the relationship between those components when assessing a company concerning the environmental performance, presenting and risk profiles.

The thesis is organized as follows; the second chapter presents the theoretical base on which the research has been founded on. The third part reveals the data collection methods, and continues with the empirical framework and the analysis of the results presented. The last chapter presents conclusions and suggestions for future research.

5 Gray, Rob (2006). Does sustainability reporting improve corporate behaviour? Wrong question? Right time? Accouting and Business Research.International Accounting Policy Forum p. 82

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CHAPTER 2 – THEORY

2. THEORY

The theory presented in this chapter is to be seen as the foundation on which the research is based on. Key areas include the corporate reporting practice, environmental risk of corporate activities, financial analysts, the impact on valuation and the theory of value relevance. The chapter concludes with a summary model of the presented theoretical background. The definition of environmental information in this study is presented in Appendix 1 and contains of seventeen key words related to environmental information.

Similar key words and a similar approach have been applied in previous research within the sustainable investment research area⁶, and this study will be conducted with influence from this type of research method.

2.1 Corporate reporting practice

Greater attention to environmental matters have historically been associated with higher costs and lower profit, but today’s business climate and the way of doing business requires another approach towards environmental issues. Especially in industrial sectors, companies can no more ignore environmental issues and consequences of their operations due to environmental laws, regulations, pollution permits and other environmentally related topics⁷.

The immediate and future costs and benefits of environmental activities are a difficult topic to examine, especially in terms of how to define the monetary obligations in

relation to environmental activities. It is not as simple as investing in a new machine that based on pre-calculations and various mathematic estimates will generate revenue and profit within a certain given time frame. Current accounting praxis does also set up a number of limitations when examining to the consequences of environmental activities⁸. A common view among researchers is that the increase in environmental reporting from companies the last few decades is a consequence of a growing demands from the public and the society, rather than initiatives from the companies itself⁹. These findings are vital when assessing the environmental information presented in annual reports and 10K- forms. Some researchers even suggests that the increase of CSR and environmental reporting is solely a result of companies utilize it as a PR tool¹⁰.

2.1.1 Corporate Social Reponsibility (CSR)

One part within the field of environmental information and disclosure is the existence of separate CSR reports presented and published by the companies. In addition to the compulsory annual reports it has become more and more common for companies to present a report that focuses on the company’s social responsibility, under the umbrella term Corporate Social Responsibility (CSR).

6See i.e. the Sustainable Investment Research Platform athttp://www.sirp.se

7 Fortes, Hilary (2002). The need for environmental reporting by companies. Greener management international p.78-79

8 Fortes, Hilary (2002). The need for environmental reporting by companies. Greener management international p.80-81

9 Ihator, Augustine S (2004) Corporate communication: reflections on twentieth century change. Corporate Communications: An International Journal Vol. 9 No. 3, 2004 p. 248

10 Frankental, Peter (2001). Corporate social responsibility - a PR invention? Corporate Communications: An International Journal Volume 6 . Number 1 . 2001 p. 23

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A leading practice is the Global Reporting Initiative (GRI), which have developed a framework for setting out principles and indicators for organizations around the world to apply when measuring and reporting their economic, environmental and social

performance. The cornerstone of the framework is the Sustainability Reporting

Guidelines, which have developed throughout the ten years of the existence of the GRI organization¹¹. The third generation GRI Guidelines, named the G3 Guidelines, was published in 2006. According to the organization more than 1500 companies have now declared a voluntary adoption of the GRI Guidelines, leading to the framework becoming a global standard for reporting¹².

According to statistics published by the GRI organization, a significant increase in companies adopting the GRI Guidelines can be seen the last eight years. In the year 2000 50 companies released sustainability reports according to the GRI Guidelines, a number which increased to 500 companies in 2004, followed by 750 companies in 2005, 850 companies in 2006 and now more than 1500 companies adopting the guidelines in their sustainability reporting¹³. Other studies has also observed an increase in sustainability reporting, such as statistics showing that 49 % of the companies in the S & P 100 Index presented a sustainability report in the year of 2007¹⁴.

2.2 Environmental risk

The environmental risk of a company can be measured and observed in many ways.

Traditionally, the most commonly applied environmental evaluation methods has been to evaluate the environmental risk focusing on “bad news” rather than “good news”, a finding especially appearant in Anglo-Saxon countries¹⁵. Many studies have been conducted throughout the years examining the type of information related to i.e. market value or stock price movements. For example, Chan & Milne¹⁶ conducted a study based on the types of environmentally related information and found that investors reacted negatively to bad envornmental performance while no significant reaction was appearant to good and sound environmental performance. The company-specific risks can

according to research within the field be managed through environmental preparedness and performance of the company¹⁷.

Another approach when assessing the risk profile of a company is to evaluate the industry in which the company operates. Different industries have of obvious reasons different environmental risk profiles; the banking and investment sector does not operate with the same environmental frame as the automobile industry etc. Findings of research within the field reveal that environmental regulation in polluting industries seems to increase the

11 http://www.globalreporting.org, retrieved 2008-12-14 12http://www.globalreporting.org, retrieved 2008-12-14

13 http://www.globalreporting.org, retrieved 2008-12-14

14 Anderson, Leslie (2008). Rise in Sustainability Reporting By S&P 100 Companies. Business & the Environment with ISO 14000 Updates; Oct2008, Vol. 19 Issue 10, p6

15 Cunningham, Gary, Henrik Nilsson & Lars G Hassel (2008). A study of the provision of environmental information in financial analysts research reports. Sustainable Development 16 (3), p. 185

16 Chan, Christian & Markus J. Milne (1999) Investor reactions to corporate

environmental saints and sinners: an experimental analysis. Accounting and Business Research, Vol. 29. No. 4. p. 265-279

17 Hassel, Lars G & Natalia Semenova (2008) Financial Outcomes of Environmental Risk and Opportunity for U.S. Companies.

Sustainable Development, Vol 16 (3), p. 209-210

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operation uncertainty as well as negatively affect productivity¹⁸. It is therefore of relevance to analyze the industry in which the company operates when evaluating the environmental risk profile of a company. A useful approach can therefore be to observe the environmental risk profile of a company by dividing the risk into a company-specific risk and an industry-specific risk.

The study has included a variable which evalutates the studied companies’ environmental risk profile by examining the company-specific risks as well as the industry-specific risk.

The environmental risk rating is produced by the sustainability research provider Global Ethical Standard (GES) Investments Services and presented more detailed in chapter three and Appendix 2.

2.3. Financial analysts

Financial analysts are often seen as the expertise link between the company and the various stakeholders which have interest in the company and its activities. The gathering and interpretation of information from various sources result in a recommendation of the company, often as a concrete proposal to buy/hold/sell the specific stock with a time range of normally 6-18 months.

The role of the financial analyst is a vital part in the investment value chain. The financial analysts is highly specialized in their field of profession and commonly seen as expertise for others to base decisions and take action on. A study conducted by Womack¹⁹ revealed that the analysts’ publications do have an impact on the price on the specific stock.

Womack’s research implicated that the movement of a specific stock on average was as much as five percent up respectively eleven percent down for a buy / sell

recommendation over the next few months after the recommendation being released²⁰. The results from the study is in conjunction with the common viewpoint that financial analysts are experts within their field and a recommendation is to be seen as a statement that the stock or sector does or does not appear to be correctly priced.

By conducting surveys with financial analysts, Mills et al²¹ acknowledged a percieved link between environmental performance and good economic performance of companies.

The problematic issues for the analysts seemed to be the ability to create an adequate model for explaining this percieved link. Other interesting findings from the survey-based research mentioned above are an observed lack of strategic and systematic traning and evaluation methods of environmental information for the financial analysts from top level management. The disclosure of environmental information in financial analyst reports for the studied companies hence seemed to be genereally presented ad hoc²²

Sustainable Development, Vol 16 (3), p. 199

19 Womack, Kent L. (1996) Do Brokerage Analysts' Recommendations Have Investment Value? The Journal of Finance, Vol. LI No 1, p. 163-165

20 Womack, Kent L. (1996) Do Brokerage Analysts' Recommendations Have Investment Value? The Journal of Finance, Vol. LI No 1, p. 163

21 Mills, Julie, Chris Fayers & Doug Holmes (2001) Sustainability, Socially Responsible Investment and the Outlook of Investment Professionals in Australia. Greener Management International, Spring2001 Issue 3, p.41

2222

Mills, Julie, Chris Fayers & Doug Holmes (2001) Sustainability, Socially Responsible Investment and the Outlook of Investment Professionals in Australia. Greener Management International, Spring2001 Issue 3, p.41-42

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2.3.1 Environmental information among financial analysts

The most commonly applied method when assessing a company is to base the valuation on estimated future cash flow, earnings and revenue²³. One of the main reasons that environmental information have not been in focus is because environmental information throughout the years have been viewed as an intangible asset/liability²⁴. The most common valuation methods, such as estimated future cash flow, mainly focuses on the tangible assets/liabilities and aspects which easily can be verified and measured by numbers. Traditionally investors have been assumed only interested in maximising the risk-adjusted return from investments, with the implication of no need or reason for social and environmental aspects of the investment²⁵. However there has been a shift in the last decade concerning the view on the purpose of a given investment opportunity. An increasing demand from the public to social and environmental aspects as well as a more extensive environmental legislation might affect financial analysts to more frequently involve environmental issues into the valuation process.

An Australian study conducted by Deegan & Rankin²⁶ revealed that shareholders and people within organizations that review or oversight publicly listed companies significantly consider environmental information as material to the decisions they undertake. However, stockbrokers and financial analysts differed from the results. Only 31 percent of the stockbrokers and financial analysts reported they were seeking

environmental disclosure in annual reports, compared to the total average of 66 percent.

The same numbers apply to the othermain research area, which was to examine whether the respondents felt environmental information material when assessing a company²⁷. That is an interesting conclusion related to this thesis. According to the previously mentioned research results, there appear to be not that strong connection between the amount of environmental information in annual reports and financial analyst reports.

2.4 Impact on valuation

Traditionally, accounting and financial information have been the main sources of information used by analytics when assessing a company²⁸. The focus has historically been on growth numbers. The reporting of environmental, social and ethical activities and policies have not been in focus due to various reasons; lack of compulsory directives, indistinct corporate reporting practice, and the abstract type of information environmental disclosure can be, as well as the fact that firms and the society in whole were less

environmentally oriented in the past. In recent years research have indicated a shift towards environmental and CSR considerations among professionals and analysts. Fayers

23 Liu, Nissim & Thomas (2007) Is Cash Flow King in Valuations? Financial Analysts Journal. Vol. 63 No. 2 p.56

24 Konar, Shameek; & Mark A. Cohen (2001). Does the market value environmental performance? Review of Economics & Statistics, May2001, Vol. 83 Issue 2, p281

25 Gray, Rob & Alan Murray (2006). Do financial markets care about social and environmental

disclosure? Further evidence and exploration from the UK. Accounting, Auditing & Accountability Journal Vol. 19 No. 2, pp. 230-231

26 Deegan, Craig & Michaela Rankin (1997). The materiality of environmental information to users of annual reports. Accounting, Auditing & Accountability Journal. Vol. 10 Issue: 4, p 580

27 Deegan, Craig & Michaela Rankin (1997). The materiality of environmental information to

users of annual reports. Accounting, Auditing & Accountability Journal. Vol. 10 Issue: 4 , p 573, Graph IV

28 Breton, Gaetan & Richard J. Taffler (2001). Accounting information and analyst stock recommendation decisions: a content analysis approach. Accounting and Business Research p.91

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et al²⁹ examined the environmental considerations among investment professionals in Australia, and found a change of attitude and approach among financial analysts when assessing companies concerning environmental performance. Some of the surveyed suggested environmental issues are important investment opportunities to take into consideration, while others believe environmental performance correlate positively with financial performance. The significant opinion signals that professionals within the field value environmental performance and preparedness as any other source of information.³⁰ Gray & Murray³¹ examined the relevance of social and environmental disclosure, measured in financial stock performance. Surprisingly, and in contrast to existing literature, their research demonstrated a convincing relationship between high (low) return and high (low) social/environmental disclosure. A company disclosing

environmental information only as a reason to increase stock value did not seem to be doing themselves a favour in long-term. Related to this study, these findings are

interesting from the perspective that it might act as incentives for companies to disclose social and environmental information in the reporting.

2.5 Environmental performance and disclosure

There is a general belief in financial theory that various stakeholders require information that are of relevance to the performance and future predictions of a company. However, there have throughout the years not been any consistent opinions concerning the

importance and relevance of environmental information.

The shift in view of the concept of sustainability and environmental disclosure can be seen in many ways. From the traditional regulation based cost centre, it has today shifted toward creating opportunities from the sustainability needs emerging. Companies like DuPont, General Electric and Proctor & Gamble have increased their research in

environmentally friendly products due to growing demand for products and solutions that are environmentally friendly and manufactured in a sustainable way³².

Flöstrand & Ström³³ examined the disclosure of non-financial information in 200 financial analyst and annual reports of companies included in the S&P 500 Index, and their findings revealed an insight into the relationship between those two sources of information. The amount of non-financial information in the financial analyst reports appeared to be related to the level of non-financial information in the annual reports. The size of the company also had an impact in the sense that analysts tended to include more non-financial information of relevance when assessing bigger companies. Companies tend to put a greater role to play for the non-financial information besides the historically dominating financial type of information.

29Fayers, Cocklin & Holmes (2000). Environmental Considerations in the Decision of Australian Investment Professionals. Journal of Environmental Assessment Policy and Management Vol. 2, No. 2 (June 2000) p. 196-197

30 Fayers, Cocklin & Holmes (2000). Environmental Considerations in the Decision of Australian Investment Professionals. Journal of Environmental Assessment Policy and Management Vol. 2, No. 2 (June 2000) pp. 197

31 Gray, Rob & Alan Murray (2006). Accounting, Auditing & Accountability Journal Vol. 19 No. 2, pp. 244-245

32 Beloff, Beth, Dicksen Tanzil & Karen Clarke-Whistler (2007) Sustainable Development: A Competitive Factor. Industrial Management, p8-12

33 Flöstrand & Ström (2006). The valuation relevance of non-financial information. Management Research News, Vol. 29 No. 9, p.

589 Table II.

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2.6 The value relevance theory

The value relevance theory is a vital part of the theoretical background to this study. It gives an insight into the problematic issues of assessing value creating activities of a company. Many views have been present throughout the years, where the foundation has more or less been focused on two kinds of approaches; a cost-concerned approach and a value-concerned approach.

2.6.1 Cost-concerned vs. value-concerned approach

The way environmental performance and investments aimed for environmental activities are impacting the value of a company (and in turn the relevance of environmental

disclosure) can be divided into two main schools; the cost-concerned school, which argues that environmental investments only represent increased costs of a company, and the value-concerned school, which view environmental investments as a way to create a competitive advantage on the market as well as a mean to improve financial return to investors.

The cost-concerned approach is therefore expecting a negative relationship between the performance of a firm and its environmental performance. Walley & Whitehead³⁴ argues that such win-win situations where environmental investments lead to higher financial value of a firm are very rare and the opposite are more likely to happen, especially when according to the researchers the costs of environmental activities tend to sky-rocket and provide little or no chance to a positive financial outcome.

On the other hand, the value-concerned approach merely suggests poor environmental performance does have a negative impact on the value of the intangible assets of a company, as well as companies with better environmental performance tend to have a higher market value of the intangible assets³⁵.

As shown above, there are contradicting viewpoints on the value relevance of

environmental reporting. The aim of describing different approaches to environmental performance and investments into environmental activities is to provide an insight into the difficulties of linking environmental and financial performance of a company. As mentioned above, research has revealed both negatively and positively relationships between those two variables.

The lack of coherent consistency among researchers between the relationship of financial performance and environmental performance and disclosure implicates that financial analysts have an important role to play when acting as a linkage and interpreter between the company and the investor, as well as to the society as whole.

34 Walley, Noah & Bradley Whitehead (1994). It's Not Easy Being Green. Harvard Business Review, May/Jun94, Vol. 72 Issue 3, p49

35 Konar, Shameek; & Mark A. Cohen (2001). Does the market value environmental performance? Review of Economics & Statistics, May2001, Vol. 83 Issue 2, 289

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2.7 Summary of the theoretical background

The theoretical base presented above is summarized in Table 2.1 on the next page. It is to be seen as an overview of the theory and background aspects on which the study is based on. The financial analysts act as an intermediary between various stakeholders that have interest in a particular company. The financial analysts’ supply the various stakeholders with information, and are in turn influenced by a demand of information from the stakeholders.

The financial analysts generate their reports with support from relevant sources. The company itself is one given source and environmental evaluation organizations another.

These two sources of information have been included as variables in the study in the forms of annual reports, CSR reports and environmental risk rating from the sustainable investment provider Global Ethical Standard (GES) Investment Services. A more extensive description of the data collection phase can be found in chapter three.

Table 2.1 shows that the work of financial analysts can be impacted by other relevant sources such as branch organizations, environmental groups or by accounting and

auditing standards. Other aspects influencing the financial analysts can also be the branch praxis and standards of the analyst business in general terms, as well as the value

relevance theory applied to environmentally related information.

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CHAPTER 3 – METHODOLOGY

3. METHODOLOGY

Companies in the industrial sector are due to their business operations more likely to have significant impact on the environment, as mentioned in previous chapters. The environmental information presented in annual and financial analyst reports, as well as the assessment of the environmental risks of the company and the industry in which they operate, might be a factor influencing the overall value of the company. This chapter provides the methods applied for the study. Important areas include the data collection phase, the components included in the research and the construction of the statistical framework.

3.1 The data material

The sample consists of 40 publicly listed companies in the industrial sector, which can be found in Appendix 2. The sample derives from companies that have been assessed by GES Investment Service (section 3.1.1), assessed by the specific environmental risk performance and preparedness. One further requirement is that the companies needs to have for the study relevant, published annual reports available in electronic format. The sections below will describe and examine the methods applied for the sample.

The 40 companies included in the research derive from the group “Industrial” in the MSCI 1000 World Index dated 2005-12-31. MSCI means Morgan Stanley Capital International and is a leading provider of investment decision support tools worldwide (by today merged to become MSCI Barra). The MSCI 1000 World Index applied in this research combined with the GES Risk Rating Index (see section below) is based on the 1000 largest companies worldwide, measured in market value³⁶.

The industrial sector consists of following sub groups:

• Aerospace & Defence

• Air Freights & Logistics

• Building products

• Commercial Services & Supplies

• Construction & Engineering

• Electrical Equipment

• Household Durables

• Industrial Conglomerates

• Machinery

• Marine

• Road & Rail

• Trading Companies & Distributors

• Transportation Infrastructure

36 http://www.mscibarra.com/, Retrieved 071206

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The total number of companies included from the given criteria was 41. The number then was reduced due to a lack of financial analyst reports for one company, reducing the total included companies to 40.

3.1.1 The Risk Rating Index

The Risk Rating Index applied in the research is developed by the research and

responsible investment provider Global Ethical Standard (GES) Investment Services. The organization focus is on analyzing and consulting the sustainability performance and preparedness of publicly listed companies around the world. Methods used are both quantitative and qualitative analyses. A main business target of GES Investment Service is to contribute to the development of global standards concerning human rights, business ethics and environmental issues³⁷.

One of the quantitative models developed by GES Investment Service is the Risk Rating Index, which is an analysis of the risk in the company methods of dealing with the environment, human rights and corporate governance. The analysis is based on

international norms on environmental, social and governance issues³⁸. The main goal of the analysis is to provide an overview of a company’s present sustainability status and performance as well as the future readiness of important sustainability issues.

The environmental risk rating analysis is based on two main elements; company-specific standards for environmental preparedness and performance, and industry-specific

indicators for environmental performance. Each specific analysis is based on a number of components; dialogues with the companies, information from the media and GES

partners, official documents as well as information from other types of organizations³⁹. Appendix 2 reveals the risk rating model. The rating ranges from Ac to Cc. The capital letters indicates the general level of risk in the industry where the company operates, while the case letters indicates the risk level of the specific company. The overall Risk Rating figures show the company’s ability to deal with environmental risks and

opportunities in accordance to international norms and procedures and are measured in a scale of 0-3.

3.1.2 The annual reports

The annual reports have been collected either from the company’s homepage (from the Investor Relation section or equivalent) or from email contact with their IR-departments.

The annual reports sought were published in 2005, which means most of them derive from the fiscal year of 2004. Some of the companies have non-calendar fiscal year and in those cases I have chosen the annual reports that were published in 2005. As seen in Appendix 3, some of the annual reports are i.e. for the period April 1 2004 to March 31 2005.

37 http://www.ges-invest.com, ”About us”. Retrieved 080206

38 http://www.ges-invest.com, ”Services”, Risk Rating”. Retrueved 080206

39 http://www.ges-invest.com, ”Services”, Risk Rating”. Retrueved 080206

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Due to the fact that the annual reports are from 2005 there were no complications to retrieve the sought material in electronic format. If the research period would have ranged too many years ago the search for annual reports in electronic format could have been a difficulty.

3.1.3 Corporate Social Responsibility (CSR) reporting

The CSR reports were retrieved in the same way as the annual reports above. The information was collected from the company webpage or by contact with the respective Investor Relation department. In addition I have also used an Internet website specialized on collecting and organizing separate CSR reports⁴⁰. The distinction between companies presenting separate CSR reports and companies that does not present separate CSR reports is presented in Appendix 2.

3.1.4 The financial analyst reports

The financial analyst reports have been collected from the database Investex Plus. The database is a financial database for research purposes, containing reports from 700 of the worlds top investment banks, trade firms and trade associations⁴¹. Investment firms such as Deutsche Bank, Credit Suisse and HSBC provide the database with published

company reports, industry reports as well as geographic reports.

From each company included in the research, all reports in the database between January 1, 2005 and December 31, 2005 have been collected. Some limitations have been set up to reduce the unnecessary information and optimize relevant reports:

1) The total number of reports to be included is five per company. Of the total 41 companies included in the research, everyone except three companies met this requirement.

2) The five most extensive reports have been included. The number of pages of each report range from five up to 126 pages. In some cases less extensive reports have been selected in accordance with criteria 3).

3) The composition of the financial analyst reports are preferably from different financial institutions and from different times of the year.

4) The chosen reports must contain a recommendation and/or target price. This will exclude reports that are designed only on comparing basis and solely based on numbers and statistical information.

In total 193 financial analyst reports are included in the study. The financial analyst reports are shown in Appendix 4 and Appendix 5.

3.2 Constructing the analysis model (statistical framework)

The construction of the statistical framework consists of three main components; the correlation coefficients, regression analysis and the chosen hypothesis of the research.

Those components are presented below.

40 http://www.corporateregister.com, Retrieved 080308

41 http://www.ub.umu.se, ”Databaser”, ”I”. Retrieved 20080202

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3.2.1 Correlation coefficients

An important question in this study is to examine whether a relation exists between the chosen variables. One of the most frequently used methods is to measure the existence of non-existence of a linear relationship between the variables. This method is called covariance. By standardizing the value of the measurement scale so the units will have the same value, the correlation coefficient appears, or the Pearson’s’ correlation coefficient⁴².

The correlations coefficient has to be within the range of -1 to 1, with the implication of:

• +1 indicates a perfect positive relationship.

• - 1 indicates a perfect negative relationship.

• 0 indicates no linear relationship at all.

A common method to obtain an improved graphically view of the relationship is to create a scatter plot. The scatter plot is a graph that plots the values of the variables against each other, which tells if there seems to be a relationship between the variables, what kind of relationship and it also gives the potential to find values that markedly differs from others (so called outliers)⁴³. For this reason scatter plot graphs are created from the data material and presented in Appendix 6.

Since this study is quoting a two-tailed probability (measures the possibility that the value can be either greater or less), the correlation testing shows if there exists a relationship between the variables based on the standard criteria of probabilities.

Assuming a normal distribution of the sample, a 95 % confidence interval would mean that the true value of the population will fall within those limits 95 % of the times. The same principle applies to a 99 % confidence interval, and so on⁴⁴.

3.2.2 Regression analysis

While the correlation coefficient measures relationship between variable, it does not tell anything about the direction of the relationship. The regression model means taking a step further and explaining the direction of the relationship.

A simple regression means predicting an outcome from a single variable, while multiple regressions an outcome is predicted from several predictor variables⁴⁵. As shown earlier in this chapter the study is based on two predictor variables and one outcome variable. A multiple regression model will therefore be applied to examine the two predictor

variables (amount of environmental information in annual reports and environmental risk rating) with the outcome (amount of environmental information in financial analyst reports).

42Field, Andy (2005). Discovering Statistics Using SPSS. Sage Publications, 2nd Edition. p 109-111

43 Field, Andy (2005). Discovering Statistics Using SPSS. Sage Publications, 2nd Edition. p 113

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The multiple regression analysis can then be written as following⁴⁶:

The outcome is derived from the chosen model and an error factor.

Yⁱ is the outcome variable, ^b the coefficient for the predictors ^(X), and e the difference between the predicted and observed value for ^Y.

3.2.3 The regression model

The methodology presented earlier in the chapter concludes into the regression model.

The purpose of the model is to explain the variable observed as the dependent variable;

the amount of environmental information in the financial analyst reports.

The regression model

The amount of environ- The amount of environ- Environ- mental information in = mental information in + mental + Error financial analyst reports annual reports risk

Table 3.1 The regression model

The model suggests that the amount of environmental information in annual reports and environmental risk of the company together with the error factor will explain the amount of environmental information in financial analyst reports.

3.2.4 Research hypothesis

The focus of the hypothesis is to test whether the given variables show any influence on the amount of environmental information disclosed in the financial analyst reports. The chosen variables include (i) annual reports published 2005, (ii) environmental risk rating according to the GES risk rating index and (iii) separate Corporate Social Responsibility (CSR) reports. The hypothesis section will be examined in the following three ways:

• Hypothesis I: Companies with more environmental information presented in annual reports will have more environmental information presented in financial analyst reports.

• Hypothesis II: Companies with better environmental risk rating (= seen as an approximation of better environmental risk profile) will have more environmental information presented in financial analyst reports.

• Hypothesis III: Companies with separate Corporate Social Responsibility (CSR) reports will have more environmental information presented in financial analyst reports.

46 Field, Andy (2005). Discovering Statistics Using SPSS. Sage Publications, 2nd Edition. p 157-159

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Independent variable

^(p-value) Sign prediction N t-value Significance

Annual report disclosure + 40 X X

Environmental Risk Rating + 40 X X

Separate CSR Reports + 21 X X

Table 3.2 Overview of the hypothesis

3.3 Summary of the data collection phase

The importance of this phase cannot be neglected since it is the base of all the following empirical research. This has led to weight different methods and techniques to ensure the most suitable data collection methodology.

The first main key concept (of three) is the choice to employ the GES Risk Rating Index.

A critical possible downside is the risk of applying existing data to new research. The possibility to detect inaccuracies generally decreases when applying existing data to new research⁴⁷. The GES Risk Rating Index has despite that been selected as one of the studied variables due to the acknowledgement of GES Investment Services within the sustainable research area. Similar material assembled by GES Investment Services has also been applied in other studies within the sustainability research area; Hassel &

Semenova⁴⁸ is one example.

The second key concept is the choice to include annual reports as a predictor variable.

Annual reports published in geographical diverse regions as well as in different business cultures might result in the annual reports included in the study being presented

differently. An example of this possible complication can be seen in the fact that annual reports in the US are just one component of the corporate reporting practice besides i.e.

the 10-K form. This can be a disadvantage when collection the data material as mentioned. However the risk that these assumed differences in the annual reports will have a significant impact on the study are considered as relatively low, based on the view that the size of the data material (40 annual reports, 40 risk rating numbers and 193 financial analyst reports) will be a factor helping to decrease this specific risk.

The third key component is the financial analyst reports. As seen in Appendix 4 there are differences in regards to the page size of the reports included in the study. The relatively wide page range (from five to 126 pages) could be a bias for the study. By including five financial reports for each of the companies in the study (except for two companies which did not have five reports for the year of 2005 in the database) the aim is to decrease the specific risk of presenting biased information from the financial analyst reports. Another

47 Bryman, Alan & Emma Bell (2003). Business research methods. Oxford University Press, p. 235-237

Sustainable Development, Vol 16 (3), p. 195-212

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important factor is that the analyst reports derive from different financial analysts and different analyst institutions to reduce the risk of a homogeneous sample. A criterion has therefore been set up in the data collection phase to encourage a diverse sample of the financial analyst reports.

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CHAPTER 4 – RESULTS

4. RESULTS

The results section is organized as following: first, the general descriptive statistics of the study are presented and analyzed in relation to previous research and to the general trends emerging within the field of environmental and sustainability research. This includes mean numbers, statistic ranges as well as the distinction between companies presenting separate CSR reports and companies which does not present separate CSR reports. The middle section reveals correlation of the examined variables, followed by the regression analysis of the statistic model. The chapter continues with an examination of the three hypothesises.

4.1 Scale of measure

The scale of measure has been selected to a range of 0-3, based on the scale applied in the GES Risk Rating Index. The GES Risk Rating Index implicated the higher score the better environmental risk profile of a company.

A score of 3 means the studied companies has all 17 key words (see Appendix 1) included in the annual report/financial analyst reports, and a score of 0 respectively means the company has no key word included in the annual report/financial analyst reports. The formula to translate the amount of environmental information found in the annual report/financial analyst reports to fit into the chosen scale of measure is therefore:

(Number of key words found / 17) * 3

In the prolonging of the thesis the results will at some stages be described in terms of number of key words found per annual report/financial analyst reports. Those numbers are derived and calculated from the formula presented above.

4.1.1 All 40 companies

Table 4.1 reveals an average financial analyst report rating of 0,291, an average annual report rating of 1,019 and an average environmental risk rating of 1,476. The range of rating varies from 0 to 1,059 for the financial analyst reports, from 0 to 2,118 for the annual reports and from 0 to 2,620 for the environmental risk rating. The standard deviation tends to be higher when the mean value is higher, which implies that a higher mean value for the variables result in a higher average difference from the mean value for the individual observations.

Descriptive Statistics

N Minimum Maximum Mean Std. Deviation

Financial Analyst reports 40 0,00 1,059 0,291 0,319

Annual reports 40 0,00 2,118 1,019 0,574

Environmental Risk Rating 40 0,00 2,620 1,476 0,702

Valid N (listwise) 40

Table 4.1 Descriptive statistics – all companies included in the research

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The descriptive statistics of the studied companies reveals an average of 1,36 key words found in the financial analyst reports and 5,18 key words found in the annual reports.

These numbers are interesting in the sense that it indicates that companies tend to include more environmental information than what the financial analysts do in their reports. One possible explanation behind the observed conditions can be that companies according to previous research tend to have incentives to present environmental information as a PR tool⁴⁹, while financial analysts may not have anything in particular to gain from such kind of disclosure. The low amount of environmental information found in the financial analyst reports are in consistency with previous research⁵⁰.

The attributes of the environmental information presented can also be another factor having an impact on the results. Since the study focuses on the amount of environmental information and not the charasteristics, it may be the case that the financial analysts’

foundations to include environmental information are not quantiative enough. This is in accourdance with previous research such as Mills et al⁵¹, which revealed a percieved need from financial analysts of quantifiable environmental information to be able to

incorporate environmental information into their valuation models (and hence into the analyst reports).

Descriptive Statistics CSR reporting

N Percent Valid percent Cumulative

percent

With separate CSR report 21 52,50 52,50 52,50

Without separate CSR report 19 47,50 47,50 100,00

Total 40 100,00 100,00

Table 4.2 Descriptive statistics CSR reports

As shown in table 4.2 the number of firms presenting a separate CSR report represents 52,5% of the sample, while the remaining 47,5% of the firms do not present a separate CSR report.

4.1.2 Companies with separate CSR report

Table 4.3 reveals an average financial analyst report rating of 0,277, an average annual report rating of 1,294 and an average environmental risk rating of 1,980. The range of rating varies from 0 to 1,059 for the financial analyst reports, from 0 to 2,118 for the annual reports and from 1 to 2,620 for the environmental risk rating. The standard deviation is highest for the annual reports, followed by the environmental risk rating and lastly the financial analyst reports. The mean value represents 1, 29 key words found in the financial analyst reports on average and 6, 04 key words in the annual reports.

49 Frankental, Peter (2001). Corporate social responsibility - a PR invention? Corporate Communications: An International Journal Volume 6 . Number 1 . 2001 p. 23

50 Cunningham, Gary, Henrik Nilsson & Lars G Hassel (2008). A study of the provision of environmental information in financial analysts research reports. Sustainable Development 16 (3), p. 188

51 Mills, Julie, Chris Fayers & Doug Holmes (2001) Sustainability, Socially Responsible Investment and the Outlook of Investment Professionals in Australia. Greener Management International, Spring2001 Issue 33, p 42

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Financial analyst Reports 21 0,00 1,059 0,277 0,323

Annual Reports 21 0,00 2,118 1,294 0,578

Table 4.3 Descriptive statistics – companies with separate CSR reports

4.1.3 Companies without separate CSR report

Table 4.4 reveals an average financial analyst report rating of 0,307, an average annual report rating of 0,715 and an average environmental risk rating of 0,919. The range of rating varies from 0 to 0,882 for the financial analyst reports, from 0,176 to 1,588 for the annual reports and from 0 to 1,580 for the environmental risk rating. The standard

deviation tends to be higher when the mean value is higher, which is the same findings as for all the observations together presented in Table 4.1.

Financial analyst reports 19 0,00 0,882 0,307 0,321

Annual reports 19 0,176 1,588 0,715 0,397

Table 4.4 Desciptive statistics – companies without separate CSR reports

The mean value represents 1,43 key words found in the financial analyst reports on average and 3,34 key words in the annual reports.

4.1.4 Summary of the dividing of the companies based on separate CSR reports The dividing of the studied companies based on presenting separate CSR reports has some interesting findings. Of the studied companies around half of them presented a separate CSR report in the year of 2005. Since the companies included in the study has a diverse geographical background (see Appendix 3), it is difficult to compare the results with other studies due to the specific composition of the studied companies. The results however seem normal when comparing to companies included in the S & P 100 Index, where 49 % presented a separate CSR report in 2007⁵².

The mean value for annual reports and the environmental risk rating was noticeably higher for companies presenting a separate CSR reports. This seems logical due to the fact that a CSR report in itself can be a sign of a company being environmentally

52 Anderson, Leslie (2008). Rise in Sustainability Reporting By S&P 100 Companies. Business & the Environment with ISO 14000 Updates; Oct2008, Vol. 19 Issue 10, p6

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concerned. Companies which adopt a sustainability reporting system can be seen to demonstrate a leadership position and a commitment towards sustainability and a sustainable approach to the way of doing business⁵³.

4.1.4.1 Financial analyst reports

The mean value for the financial analyst reports however proved to be higher for the companies which do not present a separate CSR report, in contradiction to the other variables and existing research. The difference was not high (1, 29 key words compared with 1, 43 key words) but still apparent. These findings must however be interpreted carefully. As seen in the scatter plot graphs in Appendix 6 as many as 40 % of the studied companies did not have any environmental information in the financial analyst reports.

For companies presenting a separate CSR report the percentage was 38 % and 42 % for the companies not presenting a separate CSR report. The scatter plot reveals no outliers but the unexpectedly high percentage of companies not having any environmental information in the financial analyst reports is clearly a factor affecting the results of the study.

4.1.4.2 Annual reports and environmental risk rating

The two independent variables, annual reports and environmental risk rating, proved to have interesting differences when comparing companies presenting a separate CSR reports and companies not presenting a separate CSR report.

The result for environmental risk rating reveals a relatively high difference; 1,980 as the mean score for companies presenting a separate CSR reports compared with 0,919 for companies not presenting a separate CSR report. In other words companies with a separate CSR reports tend to be evaluated as better prepared and performing

environmentally by the sustainability investment provider GES Investment Service. The finding seem logical since one way to become environmental concerned can be to have an organized and systematically approach to evaluate and present the company’s environmental activities and concerns in a separate CSR report.

The observed difference in annual reports is an interesting finding in the sense that it implies that companies with a separate CSR report also tend to have more environmental information disclosed in the annual report. The difference was on average 2,7 key words for the two sub categories; 6,04 key words for companies presenting a separate CSR report compared with 3,34 key words for companies not presenting a separate CSR report.

Some might suggest that presenting a separate CSR report will imply less environmental disclosure in the traditional annual report format and that all the environmental disclosure instead will be found in CSR report. Others might suggest the opposite since a separate CSR report can be seen as a prolonging of the traditional annual report format. The findings in this study support the latter due to the higher amount of environmental disclosure in annual reports for companies presenting a separate CSR report.

53http://www.globalreporting.org, Retrieved 2008-12-14

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4.2. Correlation

As discussed in the previous chapter, the correlation reveals a potential relationship between two or more studied variables. This section presents the correlation between the environmental risk rating, the annual reports and the financial analyst reports.

Distinctions are also be made between companies presenting a separate CSR report and companies that do not present a separate CSR report.

4.2.1 All 40 companies

Table 4.5 shows the correlation for all companies included in the research. The

correlation between the two independent variables, environmental risk rating and annual reports, is significant at the 1 % level. This implies that high (low) environmental information in annual reports is significantly related to high (low) environmental risk rating for the specific company.

Correlations

AN.REPOR FIN.REPO ENV.RISK

AN.REPOR Pearson Correlation 1,000 -0,044 0,576**

Sig. (2-tailed) , 0,786 0,000

N 40,000 40,000 40,000

FIN.REPO Pearson Correlation -0,044 1,000 0,031

Sig. (2-tailed) 0,786 , 0,848

N 40,000 40,000 40,000

ENV.RISK Pearson Correlation 0,576** 0,031 1,000

Sig. (2-tailed) 0,000 0,848 ,

N 40,000 40,000 40,000

** Correlation is significant at the 0.01 level (2-tailed).

Table 4.5 Correlation – all companies included in the study

None of the two independent variables seem to correlate significantly with the amount of environmental information in financial analyst reports. It even seems to be the case that high (low) amount of environmental information in annual reports is weakly related to low (high) amount of environmental information in financial analyst reports.

4.2.2 Companies with separate CSR report

Table 4.6 reveals the correlation for companies that present a separate CSR report. The findings do not reveal any significant relationship between the variables.

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Correlations

FIN.REPO AN.REPOR ENV.RISK

FIN.REPO Pearson Correlation 1,000 -0,325 0,286

Sig. (2-tailed) , 0,151 0,209

N 21,000 21,000 21,000

AN.REPOR Pearson Correlation -0,325 1,000 0,257

Sig. (2-tailed) 0,151 , 0,260

N 21,000 21,000 21,000

ENV.RISK Pearson Correlation 0,286 0,257 1,000

Sig. (2-tailed) 0,209 0,260 ,

N 21,000 21,000 21,000

Table 4.6 Correlation– companies with separate CSR reports

The same findings appears here with a weak relationship of high (low) amount of environmental information in annual reports and low (high) amount of environmental information in financial analyst reports.

4.2.3 Companies without separate CSR report

Table 4.7 shows the correlation for companies which do not present a separate CSR report. The amount of environmental information in annual reports is significantly

correlated at the 5 % level with the environmental risk rating and as well as the amount of environmental information in financial analyst reports.

Correlations

FIN.REPO ENV.RISK AN.REPOR

FIN.REPO Pearson Correlation 1 -0,070 0,465*

Sig. (2-tailed) , 0,775 0,045

N 19 19 19

ENV.RISK Pearson Correlation -0,070 1 0,470*

Sig. (2-tailed) 0,775 , 0,042

N 19 19 19

AN.REPOR Pearson Correlation 0,465* 0,470* 1

Sig. (2-tailed) 0,045 0,042 ,

N 19 19 19

* Correlation is significant at the 0.05 level (2-tailed).

Table 4.7 Correlation – companies without separate CSR reports

Both of the two observed significant correlations is of positive nature, implying that a high (low) value for one of the variables is correlated a high (low) value for the second variable.